Is M&A collapse the black swan on the horizon?

The bursting of the M&A bubble is often seen as a late cycle harbinger of doom for a stock market bull-run, but analysts are playing down comparisons with 1989 after the collapse of over $100 billion of mega-mergers in the US earlier this month.

Twenty First Century Fox’s decision to withdraw its $71 billion (£42.1 billion) offer for Time Warner was the real headline maker. Coming on the same day that mobile phone operator sprint dropped its $32 billion pursuit of T-Mobile US, the double disappointment caused shock, but hardly panic, with the S&P 500 closing flat.

The impact on Sprint and Time Warner was far more marked, however, with the former down 19% on the news, while the latter sank by 13%, wiping out a series of options on both stocks.

Despite the muted response of the broader market, there were plenty of commentators lining up to say that the M&A tailwind is over with worse surely to come.

‘Has the M&A bubble just burst with the withdrawal of Twenty First Century Fox's bid for Time Warner? Does the broken proposal have adverse consequences for the broader market?’ asked Doug Kass, president of Seabreeze Partners Management.

‘Remember on 13 October 1989, there was a mini market crash after the breakdown of the leveraged buyout of what was then UAL Corp (arguably caused by the Association of Flight Attendants pulling out of the deal). The arbitrage community was hit badly; some larger arbs even went out of business.

‘Not only did the U.S. stock market fall by about 7% in one day (and the transport sector dropped by more than 12% in two days), but the junk bond market also collapsed.

‘A mini Black Swan then…and possibly now.’

Looking beyond the hyperbole, some $997 billion of mergers and acquisitions has been carried out over the calendar year to the end of July, according to Thomson Reuters data. This up 86% year-on-year, suggesting the collapse of the two recent deals is hardly a sign of famine or a likely precursor to a 1989-style meltdown.

‘I too remember those events [in 1989], yet I don’t expect a similar result here,’ said Raymond James chief investment strategist Jeffrey Saut.

‘The main difference between then and now is that in 1989 the yield curve was inverted –the prelude to a recession- and that is not the case now. Further, the AUL deal was being financed by junk bonds and hereto that is not the case.

‘So while history sometimes rhymes, it does not necessarily repeat.’

Besides stressing the key differences between then and now, including the economy, interest rates and so forth, Ritholtz Wealth Management founder Barry Ritholtz has also poured cold water on musings around the timing of Twenty First Century Fox’s Time Warner approach in relation to the stock market cycle.

He points to a chart doing the rounds that purports to show that Fox chief Rupert Murdoch’s big acquisitions have tended to signal market peaks. The chart highlights Fox’s $5.3 billion of Chris-Craft in August 2000, in the early days of the dot.com crash, and its $5.6 billion purchase of Dow Jones, which was completed in December 2007, ahead of the financial crisis.

Even if Murdoch only made acquisitions at those major tops -- two before and now a possible third -- that small sample set wouldn't signal much of anything. ‘A sample size of two is a laughable number, too small a group to draw any significant conclusions, much less that this bull market is over.

There is no statistical significance to this data. The only thing it indicates is coincidence,’ Ritholtz said.

‘Much worse than being fooled by random correlations, or relying on a tiny sample set, is when analysts mislead by omitting contradictory information. Cherry-picking data occurs when one selects only examples of an event that confirm a thesis, ignoring or disregarding those that disprove it. This epitomises this deceptive approach.’

Indeed, over his 60-year career, Murdoch has made more than 18 major acquisitions, which, looking back at with the benefit of hindsight, have been carried out at pretty much every point in the investment cycle.

‘If we we are looking at Murdoch as a signal of a market top, then it is his bids for companies that matter and not whether they succeed,’ Ritholtz said.

‘He explored buying AOL Time Warner in 1995, by no means a market top. Same for an offer for the Yankees Yes Network in 2012 and lots of others we probably don't know about.’

As more solid indicators, Saut notes that after the two mega-mergers fell through last week, Walgreen subsequently announced it is to buy the remaining 55% of Alliance Boots it does not own for around $5.3 billion.

Meanwhile, he added, investors’ short books have shrunk to their lowest level since the collapse of Lehman Brothers. This infers the ‘smart money’ is betting that any dip will be tiny and the trade’s risk/reward characteristics are unappealing, indicating a belief that there is still life in the stock market.

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